Tuesday, December 12, 2017

All of which brings us to the "crazy" idea of backing fiat currencies with cryptocurrencies, an idea I first floated back in 2013, long before the current crypto-craze emerged.

Exhibit One: here's your typical central bank, creating trillions of units of currency every year, backed by nothing but trust in the authority of the government, created at the whim of a handful of people in a room and distributed to their cronies, or at the behest of their cronies.

And this is a "trustworthy" currency?

Exhibit Two: central banks can't become insolvent, we're told, because they can create as much currency as they want, whenever they want. And this is a "trustworthy" currency?

Exhibit three: and here's what happens when trust in the currency is lost due to excessive currency issuance: the currency goes from 10 to the US dollar to 5,000 to $1 and then to 95,000 to $1, on its way to 2,000,000 to $1:

Yes, this was once a "trustworthy" currency.

While many people expect China to issue a gold-backed currency some day, they overlook the inconvenient reality that China is creating far more fiat currency than it is adding in gold reserves. They also overlook that gold-backed means nothing if the currency isn't convertible into gold.

If it isn't convertible, it isn't gold-backed. Claiming there's gold somewhere in a vault doesn't make a currency gold-backed, as the central bank can devalue the currency it issues at will. Gold-backed means the currency is pegged at X units of currency to 1 unit of gold, and X units of currency can be exchanged for 1 unit of gold.

Since there is no real-world commodity backing the digital currency, its value must be based on scarcity and its ubiquity as money. The two ideas are self-reinforcing: there must be demand for the digital money to create scarcity, and the source of demand is the digital currency's acceptance as money that can be used to buy commodities, goods, services and (the ultimate test) gold.

Speaking of gold, correspondent Liberty Philosopher recently posed a scenario that was new to me: if gold continues losing value, could central banks dump their gold in favor of cryptocurrencies?

Yes, I realize this is anathema to those who anticipate a gold-backed currency becoming the dominant form of centrally issued currency, but the idea of governments that have debauched their currencies building reserves of decentralized and limited-in-issuance cryptocurrencies may not be as farfetched as you might imagine.

Here is Liberty Philosopher's commentary:

My understanding is that gold is kind of a reserve asset held by governments that provides the ultimate assurance that they are able to pay their debts. If the value of the assets they hold, which are a guarantee of their ability to pay, begins to erode, and the erosion in value is not a temporary or passing phenomenon, but a continuous and long-term trend, this would imply that the ability of governments to ultimately pay their debts would be eroding. If the value of gold begins to decline, governments who have gold reserves, but whose ability to pay their debts may be somewhat in question, would come under pressure to fortify their reserves as proof that they remained able to pay their debts.

If the price of gold were to continue to decline, my thought is that governments would be under pressure to sell the reserve asset that was declining in value, because the continuing decline in value would call into question their ability to repay their debts. They couldn’t just sit there and allow their reserves to decline in value year after year. They would have to act. If the need for having some kind of “hard” currency reserve remains (creditors may not want to accept newly printed bank notes in lieu of “hard” reserves), and they are forced to begin selling their gold reserves, what other hard reserve asset could they obtain or purchase? I think they could become purchasers of the most valuable cryptocurrencies as a replacement for their gold reserves.

The ideal reserve gains in purchasing power over time. If Venezuela had purchased bitcoin in size when it was $100, or even $1,000 in January 2017, its own currency wouldn't be heading to near-zero quite so quickly.

In my book A Radically Beneficial World, I proposed that nations which had debauched their centrally issued fiat currency could acquire the labor-backed currency I propose as reserves.

The acquisition of decentralized cryptocurrencies as reserves may sound crazy now, but as central banks destroy the purchasing power of their fiat currencies, all sorts of ideas that seem crazy now will start looking practical once the death spiral of the current unstable monetary regime begins.

I'm offering my new book Money and Work Unchained at a 10% discount ($8.95 for the Kindle ebook and $18 for the print edition) through December, after which the price goes up to retail ($9.95 and $20).

Monday, December 11, 2017

Those betting on a fourth bubble of even greater extremes will find their time at bat has come to an end.

The conventional investment wisdom holds that central banks will never let markets decline. This is an interesting belief, given that two previous asset bubbles based on central bank "easy money" both imploded, impoverishing believers in central bank omnipotence.

So perhaps we can say that the conventional investment wisdom holds that any asset bubble that bursts will quickly be reflated into an even more extreme asset bubble. That's certainly been the history of the past 17 years.

1. Every policy yields diminishing returns as the positive results follow an S-curve.

2. What every trader knows no longer has any predictive power.

3. Policy extremes have become normalized, leaving central banks with unintended and unpredictable consequences should they push even more extreme policies in the next bubble burst.

Radical new central bank policies work wonders in the initial boost phase (see diagram below) because the sums being deployed are so large and the policy is so extreme: quantitative easing / purchase of assets by central banks, for example: never before have central banks conjured trillions of dollars, yuan, yen and euros out of thin air and used this new currency to buy bonds, stocks and debt instruments in vast quantities for eight years running.

But over time, the novelty and effectiveness of the radical policies wear off.Participants habituate to the policies, which become a given that can not be removed without disrupting the markets.

Traders are always seeking an edge, and front-running central bank policy has proven to be a very effective strategy. But once everyone starts using the same strategy, it stops working. Put another way, there's no predictive power left in what everyone knows.

So central banks suppress volatility--everybody knows that. Central banks jump in and buy every dip, stopping any decline in its tracks with unlimited buying of assets. Everybody knows this.

Eventually, everyone is on the same side of every trade. At that point, there is only one movement left--a reversal that catches everyone by surprise.

The third dynamic is that central banks are visibly getting nervous about the unintended and unpredictable consequences of their extreme policies. It's all fun and games when central banks are buying trillions of assets with money created out of thin air, but how do you stop the asset purchases when everyone depends on them as the foundation of the markets?

Are there no consequences from holding interest rates near zero for eight long years?

What about political blowback from the rising wealth inequality that central banks have fueled?

Policy extremes trigger unintended consequences as a result of being extreme.You can't throw around trillions and not generate expectations, incentives and blowback from those who don't benefit from the extreme policies.

Central banks don't control the consequences of their policies. If they respond to the popping of the current bubble with tens of trillions in new asset purchases, they might find this policy is nowhere near as effective as when it was unleashed in 2008.

Once markets grasp that central banks have lost control of the consequences of their policies, confidence, faith and trust in central banks "saving the day" will evaporate. The likely result of this realization is that markets will plummet to new lows rather than reach new highs.

Three bubbles/strikes and you're out. Those betting on a fourth bubble of even greater extremes will find their time at bat has come to an end.

I'm offering my new book Money and Work Unchained at a 10% discount ($8.95 for the Kindle ebook and $18 for the print edition) through December, after which the price goes up to retail ($9.95 and $20).

Sunday, December 10, 2017

What if bitcoin is a reflection of trust in the future value of fiat currencies?

I am struck by the mainstream confidence that bitcoin is a fraud/fad that will soon collapse, while central bank fiat currencies are presumed to be rock-solid and without risk. Those with supreme confidence in fiat currencies might want to look at a chart of Venezuela's fiat currency, which has declined from 10 to the US dollar in 2012 to 5,000 to the USD earlier this year to a current value in December 2017 of between 90,000 and 100,000 to $1:

On 1 December, the bolivar traded in the parallel market at 103,024 VED per USD, a stunning 59.9% depreciation from the same day last month.

Analysts participating in the LatinFocus Consensus Forecast expect the parallel dollar to remain under severe pressure next year. They project a non-official exchange rate of 2,069,486 VEF per USD by the end of 2018. In 2019, the panel sees the non-official exchange rate trading at 2,725,000 VEF per USD.

If this is your idea of rock solid, I'll take my chances with bitcoin, which currently buys more than 1 billion bolivars. Of course "it can't happen here," which is precisely what the good people of Venezuela thought a decade ago.

Gordon Long and I discuss Fiat Currency Failure (The Results of Financialization - Part IV) in a new 31-minute video. The bottom line is that fiat currencies are debt-based claims on future profits, energy production and wages, claims that are expanding far faster than the real economy and the productivity of the real economy.

In effect, fiat currencies and debt are like inverted pyramids resting on a small base of actual collateral.

If you look at the foundations of fiat currencies, you find loose sand, not bedrock. Massive mountains of phantom wealth have been created by central-bank inflated bubbles, bubbles based not on actual expansion of net income earned from producing goods and services, but on financialization, the pyramiding of debt and leverage on a small base of real assets.

Creating "free money" in unlimited quantities impoverishes everyone who holds the currency. In the initial boost phase, the issuance of "nearly free money" to borrowers, qualified or not, generates the illusion of prosperity. But once the boost phase ends, reality sets in and marginal borrowers default, inflation moves from assets (good inflation) to real-world essentials (bad inflation), and creating more "free money" ceases to be the solution and becomes the problem

Yes, cryptocurrencies are risky--but so are fiat currencies. Illusory "wealth" evaporates, and expanding credit-based "risk-free money" at rates that exceed the rate of expansion of the real economy reduces the purchasing power of all those holding the currency. Eventually trust in the currency, and in the authorities who control its issuance, erodes, and a self-reinforcing feedback loop turns the rock-solid currency into sand.

What if bitcoin is a reflection of trust in the future value of fiat currencies? Those dismissing bitcoin as a fad might be missing the point: trust in the authorities who control the expansion of fiat currencies might be eroding fast in a certain segment of the populace.

And more importantly, they might be right, and everyone who placed their trust in the authorities who control the expansion of fiat currencies ends up holding a handful of sand.

I'm offering my new book Money and Work Unchained at a 10% discount ($8.95 for the Kindle ebook and $18 for the print edition) through December, after which the price goes up to retail ($9.95 and $20).

What few observers seem to grasp is that automation goes through two distinct stages of profitability: when robots/automation first replace high-cost human workers, profits soar. Observers then draw projections based on the belief that these initial profits will continue essentially forever.

But this initial boost phase of profits gushing from automation is short-lived;as the tools of automation are themselves commoditized and become available to anyone on the planet with some capital and ambition, lower cost automated competitors come to market, destroying the pricing power of the first adopter.

Once an enterprise is competing only with other automated enterprises, profits fall to near-zero as lower cost competitors emerge. Competitive advantages are small once a field has been commoditized/globalized, and there is little pricing power left except for brands that establish some cache people will pay extra to have and hold.

But everything that's been commoditized will no longer be profitable, as the competitive advantage of replacing human workers with robots vanishes once competitors have also replaced their human workers with robots.

Karl Marx described this dynamic of profits cratering and then vanishing in the 19th century. Marx described the consequences of over-investment in commoditized production and the resulting over-capacity: when anyone with access to investors or credit can buy the same machinery—that is, the machines are interchangeable commodities such as sewing machines, power looms, etc.--the capacity to produce rises as every competitor attempts to lower the unit cost of each product by producing more.

In other words, the only competitive advantage in an economy of commoditized machines and products is to increase production by over-investing in productive capacity. If competition has lowered the price of products, those who can double their production will achieve profitable economies of scale.

Over-investment and overcapacity are intrinsic dynamics of production; those who fail to invest heavily in increasing capacity will become unprofitable. Once their capital is destroyed, they vanish in insolvency.

As Marx explained, every enterprise is driven to pursue the same strategy, and the end result is massive over-investment and overcapacity. The flood of products overwhelms demand, and prices fall below the production costs.

Over-investment leads to overcapacity that devalues whatever is being produced.

This leads to a counter-intuitive result: over-investment destroys capital.

The naïve faith that robots will generate so much wealth that humans will have no work has it backward: over-investment in commoditized robots and their commoditized production will destroy capital, not create it.

Recall that enterprises don’t have profits, enterprises only have expenses. Robots will never be free, due to their intrinsic complexity and use of resources and energy. As robots and other tools of automation become commodities that anyone can buy, whatever robots can produce is devalued accordingly.

In other words, whatever commoditized robots can produce is no longer profitable; rather, the production destroys capital.

This leads to a startling conclusion: this destruction of capital must be subsidized by taxing whatever is still profitable, i.e. whatever cannot be commoditized or automated.

In other words, enterprises profiting from human labor that can’t be replaced by commoditized (interchangeable) robots will be subsidizing intrinsically unprofitable robotic production that destroys capital.

Exactly how will all these robots create unimaginable wealth when every moment they’re in production they’re destroying capital? It will fall to the remaining profitable enterprises and their human employees to subsidize the capital-destroying robots.

Robots can only perform profitable work, and in a fully commoditized production chain, very little production will be profitable. This raises a question: who will subsidize all the unprofitable robots? Who will buy them, program them, repair them and energize them? Who will subsidize all this capital-destroying work performed by robots?

The fantasy that robots will do all the work of stripmining the Earth to provide for our endless overconsumption, and generate vast profits doing so, is just another manifestation of an intrinsically destructive and unsustainable Mode of Production.

The opportunity to get a 25% discount on my new book vanishes tomorrow morning.

This essay was drawn from my new book, Money and Work Unchained, which I'm offering to my readers at a 25% discount ($7.45 for the Kindle ebook and $15 for the print edition) through Saturday, December 9, after which the price goes up to retail ($9.95 and $20).

Thursday, December 07, 2017

Robots are only cost-effective in the narrow niches of commoditized tasks.

In the view of Universal Basic Income (UBI) advocates, substituting robots for human labor will not only free virtually all humans from working, it will also generate endless wealth because the robots will be doing almost all of the work.

To reach a more realistic understanding of the economics of robots, let’s return to author Peter Drucker’s maxim: enterprises don’t have profits, enterprises only have expenses. In other words, from the outside, it looks as if businesses generate profits as a matter of course.

Enterprises don’t have profits, enterprises only have expenses captures the core dynamic of all enterprises: the only reliable characteristic of enterprises, whether they are owned by the state, the workers or private investors, is that they have expenses. Profits--needed to reinvest in the enterprise and build capital--can only be reaped if revenues exceed the costs of production, general overhead and debt service.

Robots are complex machines that require substantial quantities of energy and resources to produce, program and maintain. As a result, they will never be super-cheap to manufacture, own or maintain.

Robots, and the ecosystem of software, engineering, spare parts, diagnostics, etc. needed to produce, power and maintain them, are a large capital and operational expense.

The greater the complexity of the tasks the robot is designed to complete, the greater the complexity and cost of the robot.

Robots only make financial sense in a very narrow swath of commoditized production, or in situations such as war or hazardous rescue missions where cost is not the primary issue.

Compare the following two tasks and the cost and complexity of the robots needed to complete them in a cost-effective manner.

Task one: move boxes around a warehouse with flat concrete floors and fixed shelving mounted with hundreds of sensors to guide robots.

Task two: navigate extremely rough and uneven terrain with no embedded sensors, dig deep holes in rocky soil, and plant a delicate seedling in each hole. Each hole must be selected by contextual criteria; there is no pre-set grid pattern to the planting.

The first task has all the features that make robots cost-effective: easily navigable flat floors, fixed, easily mapped structures embedded with multiple sensors, and a limited, easily programmable repertoire of physical movements: stock boxes on the shelving, retrieve boxes from the shelving. The compact working space makes it practical to reprogram, recharge and repair the robots; spare parts can be kept onsite, and so on.

The second task--one of the steps in restoring a habitat--has none of these features. The terrain is extremely uneven and challenging to navigate; the varied surfaces may be hazardous in non-obvious ways (prone to sliding, etc.); there are no embedded sensors to guide the robot; it’s difficult and costly to service the robots onsite, and the task is extremely contextual, requiring numerous judgments and decisions and a wide variety of physical steps, ranging from the arduous task of digging a hole in rocky ground to delicately handling fragile seedlings.

Exactly what sort of robot would be capable of completing these tasks without human guidance? A drone might be able to ferry the fragile seedlings, but any drone capable of landing and punching a hole in unforgiving ground would be very heavy. Combining these disparate skills in one or even multiple robots—the heavy work of digging a hole in rocky soil on uneven ground, embedding a fragile seedling in just the right amount of compost and then watering the seedling deeply enough to give it a chance to survive—would be technically challenging.

And what profit is there to be earned from this restoration a public-land habitat? Since the habitat is public commons, there is no customer base to sell high-margin products to. If the state is paying for the job, it chooses the vendor by competitive bidding. Given the conditions, a vendor with human labor will likely be more reliable and cheaper, as this is the sort of work that humans are supremely adapted to perform efficiently.

Given that restoring a habitat generates no profit, perhaps the work is done entirely by volunteers.

In any of these cases, a costly array of robots facing a daunting challenge that could cause multiple failures (robots sliding down the slope, seedlings crushed, too little compost, compost over-compressed, water didn’t soak in, etc.) is simply not cost-effective.

You see the point: humans have few advantages in a concrete floor warehouse with fixed metal shelving. Robots have all the advantages in that carefully controlled environment performing repeatable, easily defined tasks. But in the wilds of a hillside jumble of rocks, fallen trees, etc., handling tasks that require accuracy, strength, judgment, contextual understanding and a delicate touch, humans have all the advantages.

In other words, robots are only cost-effective in the narrow niches of commoditized tasks: repeatable tasks that are easy to break down into programmable steps that can be performed in a controlled environment.

Those with little experience of actually manufacturing a robot may look at a multi-million dollar prototype performing some task (often under human guidance, which is carefully kept off-camera) and assume that robots will decline in price on the same trajectory as computer components.

But the geometric rise in computing power and the corresponding decline in the cost of processing and memory is not a model for real-world components such as robots, which will continue to be extraordinarily resource and energy-intensive even if microchips decline in cost.

Vehicles might be a more realistic example of the cost consequences of increasing complexity and the consumption of resources: vehicles haven’t declined in cost by 95% like memory chips; they’ve increased in cost.

Self-driving vehicles are another example of how commoditized automation can be profitable performing a commoditized task. First, roadways are smooth, easy to map and easy to embed with sensors. Second, vehicles are intrinsically complex and costly; the average price of a vehicle is around $40,000. The sensors, electronics, software and motors required to make a vehicle autonomous are a relatively modest percentage of the total cost of the vehicle. Third, manufacturing vehicles is a profitable venture with a large base of customers. Fourth, the actual tasks of driving—navigating streets, accelerating, braking, etc.--are relatively limited in number. In other words, driving is a commoditized task that lends itself to automation.

Once again, robots have multiple advantages in this commoditized task as they are not easily distracted, don’t get drunk, and they don’t fall asleep. Humans have few advantages in this environment. And as noted, manufacturing autonomous vehicles will likely be a highly profitable business for those who master the processes.

Since so much of the production of goods and services in the advanced economies is based on commoditized tasks, it’s easy to make the mistake of extending these very narrowly defined capabilities in profitable enterprises to the whole of human life. But as my example illustrates, a wide array of work doesn’t lend itself to cost-effective robots, as robots have few if any advantages in these environments, while humans are supremely adapted to doing these kinds of tasks.

In effect, proponents of Universal Basic Income (UBI) assume robots will be able to perform 95% of all human work, ignoring the limitations of cost: robots will only perform work that is profitable, and profitable work is a remarkably modest subset of all human labor.

But this is not the truly crushing limitation of robots; that limit is intrinsic to the economics of automation.

This essay was drawn from my new book, Money and Work Unchained, which I'm offering to my readers at a 25% discount ($7.45 for the Kindle ebook and $15 for the print edition) through Saturday, December 9, after which the price goes up to retail ($9.95 and $20).

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